The IRS has released the Applicable Federal Rate tables for June 2012, and the rates remain very low.  

The annually compounded Short-term (0-3 years), Mid-term (3-9 years), and Long-term (9+years) rates are .23%, 1.07%, and 2.64% respectively, and the Section 7520 Rate (used to value annuities, remainders and reversions is 1.2%.

It continues to be an excellent time to use intra-family loans and estate freeze transactions for income, gift, and estate tax planning.

A recent post by Deborah Jacobsat Forbes.com discussed Facebook’s founder, Mark Zuckerberg’s possible use of tax planning techniques to make large tax free gifts. Ms. Jacobs’ post points to footnotes, contained in the offering statement, which indicate Zuckerberg and several other Facebook executives are each a trustee of their own annuity trust. Jacobs believes these footnotes suggest each of them have established a grantor retained annuity trust (GRAT), and I think that is a reasonable inference. GRATs can be a very effective wealth transfer tool, particularly where rapidly appreciating assets are used. I think stock in a company which has changed the way a large portion of the population interacts with each other qualifies as such an asset, even more so when the stock will soon be offered in the largest tech IPO in history.

A GRAT, for which there is expressed authority in the tax code, involves the transfer of assets to a trust in exchange for an annuity payment for a set number of years. The value of the annuity interest is calculated based on the size and term of the annuity, along with an imputed interest rate prescribed by the IRS (the section 7520 rate). The difference in value between the assets transferred and the annuity interest retained by the Settlor is a gift, but if the values are the same there is no gift.

This is where the magic comes in. If the assets transferred appreciate at a rate higher than the section 7520 rate, which is currently 1.4%, the trustee can make all of the required annuity payments and all the excess appreciation is effectively transferred with no gift tax liability. Between 1965 and 2005 the average rate of return in the first 21 days following an IPO was 22%.

Jacobs suggests that Zuckerberg transferred a little over 3.6 million shares at a value of $0.83/share for a total value just above $3 Million. She assumes that the Facebook stock appreciates 3.6% for 4 years, and in year five the company goes public at $40/share. At the end of a five year GRAT term, Zuckerberg’s trust could hold more than $37 Million worth of stock, without incurring gift tax, a potential $17 Million in tax savings for his heirs.

But you do not need to be worth $17.5 Billion (Zuckerberg’s estimated wealth) to make a GRAT work for you, and you don’t have to own the next Facebook. At AMM we have helped clients who own companies whose stock is expected to appreciate in the near to mid-term use GRATs with great effectiveness.

As a general illustration, let us take a corporate executive (unmarried with a net worth of $8 Million), who over the course of several years has received stock grants as part of his compensation for a privately held company. The stock, valued at the IPO offer price, is worth $1,000,000. If that executive transferred his stock into a GRAT this month and took back approximately $150,000 for 7 years, there would be no gift on the transfer. If the Trustee then cashed out the stock interest in the first three weeks following the IPO, invested the proceeds and earned 5% a year, at the end of the GRAT term the trust would own assets worth $470,000, a potential $211,000 in tax savings.

In addition, the estimated tax savings do not include the possibility of a lower valuation if the transfer is done several years before the IPO is planned, and if the Trustee thinks the originally held stock will out-perform the market (maybe it is Facebook stock) there is no requirement to liquidate and diversify. Also, the estimated tax savings do not take into account possible valuation discounts which may be available on transfers of minority interests in private companies (which can easily be 30% or more). With respect to the above example, $211,000 is probably a conservative estimate of the savings produced by a well designed GRAT.

Moreover, you don’t need to be looking at an impending IPO to use a GRAT. Any asset which is expected to appreciate at a rate above 1.4%, or an asset which currently has a depressed value, but is expected to rebound, may also be good. Closely-held stock, real estate, and even a portfolio of publically traded securities are assets which can be used to fund a GRAT.

The GRAT is one of many tax planning techniques that can be used by wealthy taxpayers to reduce their tax burden. By Ms. Jacobs’ estimates, Mark Zuckerberg and his colleagues may have used GRATs to transfer almost $205 Million dollars without tax; potentially saving them nearly $92 Million in taxes. All wealthy taxpayers have this same opportunity, now that is something to “Like”.

My colleague, Alan Wandalowski, has some additional commentary on opportunities with GRATs, here.

The IRS has released the new applicable federal rate tables for March 2012, and they remain the same as they were in February.  The Short Term (0-3 years) rate is .19%, the Mid-Term (3-9 years) rate is 1.08% and the Long Term (9+ years) rate is 2.65%, with annual compounding. The I.R.C. § 7520 Rate, used to calculate the value of annuities, life interests, and remainders, remains at 1.4%See Rev. Rul. 2012-9.

It continues to be a favorable environment for Federal Estate, Gift, and Generation-Skipping Transfer tax planning, as the use of many common estate freeze techniques including grantor retained annuity trusts (GRATs) and installment sales to grantor trusts (IGTs) work best when interest rates are low.

UPDATED 1/19/2012:

The IRS has released the applicable federal rate tables for February 2012.  The rates remain virutally the same, with the 7520 Rate at 1.4% and the lowest short term rate at .19%.  Check out Rev. Rul. 2012-7. 

AFRs remian low in January ---

The IRS recently released the AFR (applicable federal rate) tables for January 2012. Rates continue at historic lows. The 7520 Rate, which is used to value a taxpayer’s interest in many common estate planning structures, such as the grantor retained annuity trust (GRAT) is only 1.4%. Other rates are similarly low. Certain loans, typically made between family members, can be made at rates as low as .19% without triggering imputed interest income to the lender.

The low interest rate environment means that there continues to be opportunities for wealthy individuals and families to engage in Federal Estate Tax planning.

Check out the January AFR Tables here.

Recently, the media has brought a lot of attention to the expiration of the 2011 payroll tax holiday, which reduced for this year only an employees tax to 4.2%. As it stands, the tax holiday will end and payroll taxes will be increased to 6.2% beginning January 1, 2012.

However, the media has given less attention to the expiration of a number of other tax incentives designed to increase investment, create jobs, and encourage philanthropy. The expiring provisions include these five, and many others.

-         The 15 year depreciation schedule for qualified leasehold improvement property, qualified restaurant property, and qualified retail property under Section 168(e), for property placed in service after 2011, will generally be increased to 39 years.

-         The 100% bonus depreciation allowance for certain qualified property under Section 168(k)(1) and 168(k)(5), will be reduced in 2012 to 50% for most property.

-         The expensing election under Section 179, $500,000 in 2011, will be reduced to $139,000 in 2012.

-         The Work opportunity tax credit (WOTC) under Sec. 51(c)(4) expires (except for qualified veteran hires).

-         The elimination of enhanced charitable contribution deductions for food, books, and computer equipment under Section 170(e).

Congress could step in and extend some or all of the expiring tax incentives, and there are several current proposals with respect to the payroll tax holiday. However, it is hard to have confidence that Congress can agree on anything these days. It may only be December 1, but the holiday could be over.